Controversial regulation 28 changes came into effect in February 2022, allowing SA retirement savings funds to increase their offshore allocation from 30% to 45%.
This led to a range of negative outcomes, which were probably not intended or expected at the time.
Domestic funds had about R1.6-trillion of offshore assets, representing about 30% of their total assets, according to Reserve Bank data.
Increasing the offshore limit from 30% to 45% suggests the potential for up to R800bn of outflows from the local savings industry. Relative performance between offshore markets and the JSE, along with resulting weakness in the rand, would reduce the ultimate quantum of outflows.
Estimates suggest local funds are now about 40% offshore, and thus two-thirds of the way through the reallocation process.
So, what were the negative consequences of the new offshore limit?
The outflows weakened the rand, boosted import inflation and caused the Bank to be more hawkish than otherwise required. A weaker rand boosts inflation. Higher interest rates hurt everyday consumers with mortgages and vehicle loans.
The move offshore reduced demand for SA equities and government bonds permanently. This was to the detriment of the JSE and A2X exchanges, asset consultants, asset managers, stockbrokers and retail savers.
JSE central order book liquidity has fallen, pushing more trade into the end-of-day auction, asset consultants have lower assets under advice, asset managers have lower assets under management, and stockbrokers experience reduced trading volumes. All of the above are SA taxpayers and employers.
Retirement savers experience a weaker rand, higher living costs, lower SA asset values, and end up being diversified into more expensive offshore equities and bonds with lower yields. To illustrate the expensiveness of offshore markets: the US represents 62% of global equity market capitalisation, against its 26% GDP share, while US equities are trading in the 98th percentile of most expensive versus rest of world equities.
Importantly, the reduction in demand for SA government bonds has been evidenced through lower demand at subsequent government bond auctions. Lower government bond demand raises the interest cost on government debt. All South Africans are losers when government interest costs rise, as the budget deficits are more expensive to fund.
A combination of a weaker rand and lower JSE share values reduce the dollar value of SA equities, which lowers SA’s country weight in the emerging market benchmarks. This means less active and passive emerging market inflows will reach SA in future, resulting in lower offshore demand for SA equities.
As managers focus more attention on very large offshore companies, they reduce analysis of small SA companies. These become cheaper by the day, thus raising their cost of capital, and making new listings unattractive. It’s worth noting that over the past 30 years, the universe of JSE-listed companies has shrunk from about 700 to 300.
The JSE and investors lose out as this once exciting part of the market shrinks.
Greater offshore allocation reduces demand for SA shares that can be better replicated offshore — Sasol, for example.
Sasol significantly underperformed the rand oil price, partly as a result of regulation 28-related selling.
While pension funds should be well diversified, they do receive favourable tax treatment from the National Treasury, and their regulation should be neutral to positive towards the country, not net negative.
Money invested offshore does unfortunately not have any imperative to facilitate transformation in SA. On the other hand, money invested with an SA manager, or in SA companies, has an obligation to follow transformation guidelines. Foreign managers contribute nothing to our efforts to train or employ previously disadvantaged South Africans and don’t have an SA office or employees. There is no sense in increasing transformation requirements if you are shrinking the pool of assets that need to follow a transformation path.
Foreign managers of SA money earn fees offshore and pay no taxes on this revenue in SA. It also reduces the domestic funds available for infrastructure investment under regulation 28.
As a country, we need our bond investment base to grow, our exchanges to be more liquid, and larger, our global index weights to be greater, and our infrastructure to improve via the private sector or public-private partnerships.
The original 30% allocation was adequate, especially considering that the JSE has a large offshore component via companies like AB Inbev, Anglo American, BHP, Bidcorp, Glencore, Naspers, Prosus, Richemont and our resource companies, who collectively account for 57% of JSE market capitalisation.
If investors want more offshore exposure, and greater diversification than the original 30% allocation, they can do so via their personal offshore allowances.
As South Africans, we need to recognise what’s not working and change things for the better.
It’s the policy of the government to accelerate transformation, support localisation, and for the finance ministry to borrow responsibly at the lowest interest rate possible.
The increased offshore limit has had the exact opposite effect. Surely a rethink is required now that the negative consequences are evident.
• Van Rensburg is a strategy consultant to All Weather Capital.
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